‘Big Short’ investor sees disaster brewing in housing markets

An aerial view shows a flooded neighborhood in the unincorporated community of Pajaro in Watsonville, California on March 11, 2023.

Josh Edelson | AFP | Getty Images

More than a decade after a mortgage meltdown in the United States threatened to destroy the international financial system, a “Big Short” investor once again sees financial disaster brewing in the real estate market.

Dave Burt, CEO of investment research firm DeltaTerra Capital, which aims to help clients manage climate risk, was one of the few skeptics who acknowledged the housing market was on the brink of collapse in 2007 .

He helped two of the protagonists of Michael Lewis’ best-selling ‘The Big Short’ bet against the mortgage market on the eve of the global financial crash of 2008. It turned out they were right and won billions.

Now Burt thinks an overlooked climate risk could see history repeat itself.

“I’m always on the lookout for these big systemic issues and there are a number of reasons for that,” Burt told CNBC via videoconference.

“Professionally, if something is mispriced, then as an investor, which has been my job for most of my career, your main opportunity to add value is to identify something that is either too cheap to buy for your customers or something that is too expensive for your customer to sell,” he said.

“From a personal perspective, and it’s partly based on that professional perspective, I’ve seen when it goes wrong, how badly it can impact economies and society and our most vulnerable. And I really think about the post-global financial crisis period here in the United States from 2008 to 2012 where there was an enormous amount of human suffering.”

Eventually, you’re going to reach a local or national tipping point where there will be some sort of bubble bursting.

Jeremy Porter

Climate Implications Lead at First Street Foundation

Burt said research from DeltaTerra Capital suggests that 20% of U.S. homes are “significantly exposed” to a mispricing problem due to flood risk. If it materializes, he warned the fallout could resemble the extraordinary correction seen during the global financial crisis.

“We think this repricing problem is perhaps a quarter of the size and magnitude of the [global financial crisis] overall, but of course very, very damaging within these exposed communities,” Burt said.

His comments come at a time when the housing market is currently experiencing a major fundamental shift due to rising mortgage rates and as global central banks continue to fight inflation by raising interest rates.

In turn, Burt says some cracks are starting to show in terms of the cost of insurance. He noted Florida’s recovery of Hurricane Ian was an issue he was watching closely, particularly because this storm surge exposed a flood insurance nightmare for owners.

“Are they going to go sinkholes this year? I’m not sure,” Burt said. “But an observation of the most frequent fundamental data on home sales and home inventory indicates that things are definitely heading south for these exposed properties.”

The overvalued US real estate market?

While most investors remain skeptical about the impact of climate risks on their portfolios, a recent study warned that the US housing market could be overvalued by around $200 billion due to unrated flood risks.

The analysis was published in mid-February in the journal Natural climate change. Written by researchers from the Environmental Defense Fund, First Street Foundation, and the US Federal Reserve, among others, the study modeled property-level changes in flood risk across the United States. over the next three decades and warned that low-income households were particularly vulnerable to home value devaluation.

“The main reason this matters from our perspective is that climate risk is not priced into the housing market,” Jeremy Porter, head of climate implications at the First Street Foundation, told CNBC.

“Current costs or home assessments don’t take into account the realization of this real flood risk, and it doesn’t take into account the fact that we have huge overvaluation attached to properties across the country.”

Porter warned that as people continue to lack sufficient information about climate risks when buying their homes, the danger remains that households will lose a significant amount of their property value overnight. .

“It’s not that far-fetched to say you’ve hit a tipping point,” Porter said. “It may be community by community. It may be a bigger tipping point that you hit across the country in the real estate market. But eventually you’re going to hit a local or national tipping point where there’s going to be a type of bubble that bursts.”

Aerial photos show damage to Fort Myers beach on March 1, 2023, caused by Hurricane Ian, which made landfall in late September 2022.

Orlando Sentinel | Tribune News Service | Getty Images

Currently, the study says nearly 15 million U.S. properties face an annual probability of flooding of 1%, with expected annual damage to residential properties expected to exceed $32 billion.

He also warned that the increasing frequency and severity of flooding amid the worsening climate emergency could see the number of US properties at risk of flooding increase by 11% and average annual losses jump by at least 26%. by 2050.

“When you’re buying a home, one of the most important considerations is the cost of maintaining that home, and I think a lot of important decisions are made based on that,” Burt said.

“At the end of the day, until people have good information about what those climate-related costs are going to look like, we’re creating new problems every day. I think that’s really the crux of the matter.”

Reflecting on the study’s findings, Jesse Gourevitch, a postdoctoral researcher at the Environmental Defense Fund, told CNBC that overpricing was more prevalent among lower-income homeowners.

He added that “if price deflation were to occur, it would have the potential to widen wealth gaps in the United States and exacerbate inequality.”

Another significant risk, Gourevitch said, was likely to be the potentially adverse effects on local government tax revenues, as total municipal revenues are typically heavily dependent on property tax revenues. “And having that tied to a physical asset that’s exposed to climate change, I think, introduces a lot of risk to the stability of that income stream,” Gourevitch said.

“A humanitarian crisis”

Munich Re, the largest reinsurance company in the world, observed heavy economic losses in 2022 as the climate crisis has caused more extreme weather events, such as Hurricane Ian in the United States and apocalyptic floods in Pakistan. Reinsurance refers to insurance for insurance companies.

He estimated those losses amounted to $270 billion last year, of which about $120 billion was covered by insurance. Total insured losses continued the high loss trend of recent years.

“At the end of the day, someone has to pay for these growing losses,” Ernst Rauch, climatologist and chief geologist at Munich Re, told CNBC. “Whether it’s insured or not, it’s a growing economic burden. “

One area of ​​particular concern, Rauch said, was flash flooding. This is a specific type of flood in which rain falls so quickly that the ground below cannot shed it fast enough.

He quoted the excessive flooding observed in Germany in 2021 which caused rivers to overflow to devastate cities across West Germany, Belgium, Austria and parts of the Netherlands, Switzerland and Luxembourg.

“These kind of extreme local and regional rainfall events are on the increase in many regions – and they are underestimated. It doesn’t matter whether we are talking about a typical homeowner in Germany or other parts of the world,” said Rauch.

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